Value unlocking
In a bid to unlock shareholder value, Valero Energy Corporation (NYSE:VLO) recently decided to spin off its retail division, CST Brands, which began trading last month.
CST Brands is an established chain with nearly 1,900 stores, which retails transportation fuels and convenience goods across Canada and the U.S. The retail division collected $13.1 billion in revenue last year, making it the second largest publicly traded convenience retailer in the U.S. To continue growing, the company has plans to open 38 new stores across Canada and the U.S in 2013. Besides that, CST Brands would also be launching its largest retail store this month, with an area of around 10,100 sq. ft.
To fund the spin off, CST Brands raised $1.05 billion through bond offerings and undertook $500 million worth of loans, which would eventually flow to Valero Energy Corporation (NYSE:VLO) as cash proceeds.
The spin-off would allow Valero Energy to perform in line with the Brent-WTI spread, which determines refinery margins. But the Brent-WTI spread has declined by over 60% since February, primarily due to excessive refinery output and relatively weaker crude demand. In my opinion, this would be a great time to pick refinery stocks, as the spread is expected to improve due to rising Indian and Chinese crude imports over the short-term period.
Peer talk
On the refining side, Valero Energy Corporation (NYSE:VLO)’s most notable competitor is HollyFrontier Corp (NYSE:HFC).
| Company | Forward P/E | PEG | Debt/Equity | Dividend Yield | Payout Ratio | Net Profit Margin |
|---|---|---|---|---|---|---|
| HollyFrontier | 9.06x | 1.67x | 20% | 2.42% | 22.38% | 9.34% |
| Valero Energy | 7.06x | 0.79x | 37% | 2.02% | 12.18% | 2.3% |
On comparing the metrics, it’s not hard to see that HollyFrontier Corp (NYSE:HFC) carries a higher yield due to its relatively higher payout ratio. Although both companies appear to be undervalued on a forward earnings basis, Valero Energy appears undervalued even with respect to its growth prospects.
With that said, HollyFrontier Corp (NYSE:HFC) is a great company with an impressive net profit margin and low debt levels. The company operates with a refining capacity of around 443,000 barrels-per-day, and recently ramped up its refining capacity at its Wood Cross facility by 13.85%. Considering its growth prospects, HollyFrontier appears to be more of an income growth stock rather than a value play.
However, Valero Energy Corporation (NYSE:VLO) appears to have a huge upside due to the CST Brands spin off. Besides the cash benefits, Valero Energy should see significant improvement in its net profit margins and this should bring it at par with its refinery peers. As a result of value unlocking, analysts at Barclays have suggested a price target of $72 for Valero Energy Corporation (NYSE:VLO).
Investors’ delight
At the current price, shares of Valero Energy carry a TTM yield of 2.02% with a meager payout ratio of 12.18%. With a Free-Cash-Flow yield of 10.15% and cash and cash equivalents of $1.72 billion, Valero Energy can comfortably sustain its annual dividend payouts of $436 million. In fact, there seems to be a lot of room for dividend hikes and there’s a possibility that the cash proceeds of $1.05 billion (or a part of it) could be distributed as one time special dividends.
Furthermore, the company has repurchased 9.7 million of its shares and had $3 billion left under its authorized capital by the end of Q1. At the current price, this accounts to a pending buyback of nearly 75.7 million shares, which should boost its dividend yield to 2.30%.
Final words
In a recent press release, management of Valero Energy Corporation (NYSE:VLO) also announced that 13 of its refineries would be running at a utilization rate of 92.8%. That’s another positive, considering the fact that its refineries are expected to produce between 2.46 million-2.52 million barrels per day for entire Q2.
Keeping all the growth prospects in mind, I firmly believe that Valero Energy is poised for an upside. But, I also believe that Barclay’s price estimate of $72 seems to be a bit far-fetched and that investors should not get too carried away by these numbers. The analyst consensus of several investment research firms suggests that there may 15%-20% upside, which seems more realistic and plausible.
The article Time to Catch This Refiner Before It Reaches Fair Value originally appeared on Fool.com and is written by Piyush Arora.
Piyush Arora has no position in any stocks mentioned. The Motley Fool owns shares of CST Brands. Piyush is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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